Juillet 2015 – Crédit – Trois sujets à regarder de près cet été

The summer time always gives mixed feelings to investors. On one hand, the hope that the summer lull will bring few market-moving headlines and little volatility and, on the other hand, the fear that some unexpected events will create some panic movements magnified by the seasonally lower market liquidity. This year is no exception to such pattern and at Eiffel Investment Group we have 3 major topics on watch.

Greece – Kicking the can down the road another time leaves Europe exposed to an unstable situation

The Eurozone (EZ) Summit of 12-13 July has delivered a new programme to fix Greece’s economic and financial woes sustainably. However, despite all the political rhetoric around a “successful outcome” for the EZ we – as many – doubt that this will be the final episode of the saga. Given the level of acrimony and mistrust reached during the Summit and the mixed feelings expressed by many participants – including Greece and Germany – about the prospects for success of the final agreement, some unexpected developments which could derail the programme execution may well take place sooner than later. Local political shenanigans in Greece, negotiation of the details of the new programme with the Troika, recapitalization, funding and resolution of the banking sector, spiraling budget deficit, sovereign debt repayment deadlines, etc. Those are a few moving parts which could easily grab the headlines and make European credit markets vulnerable again to some Greece-driven volatility. The good news is that European markets have never been in a better position than today to cope with some negative Greek developments, as evidenced by their relatively benign reaction during the climax of the recent crisis when Grexit was a clear and present danger.

The Fed – Major divergence in risk-free rates between the US and Europe could have some collateral impact for European credit

At Eiffel Investment Group, we are not “Fed watchers”, we are not monitoring the dots and we don’t have the skills to ponder on the meaning of the word “some”. That being said, we reckon that European credit markets valuations can only be sustained with a German Bund inside or close to 1% and that the strong technicals supporting our market is largely driven by the super-accommodative policies currently implemented by the ECB. In other words, should the EZ monetary policy tighten or its risk-free rates back up meaningfully and suddenly, it could impact some segments of the credit markets in a negative manner. In our view, such risk does not lie in the EZ for the moment. It is exogenous and that’s where the Fed – and the BoE to a lesser extent – fit into the picture. Should the US monetary policy, the fixed income market expectations and USD risk-free rates all point toward a rising and significant divergence with the EZ markets, then risks of increased volatility in all credit markets – including European ones – would rise. Although the market consensus seems to factor in and price a rate hike by the Fed and the BoE before the end of this year and in early 2016, respectively, we believe nobody can be complacent of the resulting market reaction almost 10 years after the last rate increase and after 7 years of Zirp.

Oil, energy and commodity prices – A potential repricing of the US HY market with second-round effects on European credit markets

We do not have an informed view on the meaning of the oil price gyrations over the past 12 months. Do they reflect a global economic slowdown and, in such case, are they a bearish signal for risk assets – including credit? Or are they mainly driven by the supply side of the equation, in which case the market should mainly focus on the economic benefits of lower energy prices in DM. HY is one segment of credit markets where the latter analysis should matter most, as most borrowers have little exposure to EM clients and should therefore benefit from improved revenues, profitability and cash flow generation as a result of lower commodity prices. However, such rationale is not that straightforward in the current US HY market where ca. 20% of the market is populated by E&P operators, oil services companies, specialized shale gas producers, pipelines and other energy groups. In such context, the renewed fall in oil and gas prices needs to be watched carefully as it could trigger a significant repricing of US HY – at least optically – and in the longer term an increased risk aversion as default rates would start to rise. There again, we consider that a yield divergence between US and European HY cannot grow indefinitely. Today’s levels where US HY trades ca. 2.50% higher than European HY in yield terms are manageable in our view as approximately half of the difference is driven by the benchmark rates and the other half by the spreads – i.e. the credit risk premium. However, given the global nature of many HY investors and their ability to reallocate capital outside of Europe into the US based on their risk-reward analysis of the two markets, we monitor very carefully the spread between those markets and the potential losses that may start to materialize in US HY.
Those three risks should not overshadow our positive view on European credit markets, which is mainly based on a unique combination of improving credit fundamentals in many segments of the markets – e.g. financials and HY corporates – and strong technicals supported by the sizeable and protracted ECB interventions. They highlight some potential challenges that we may face going forward, but they may also be the source of some attractive investment opportunities should they materialize.